A few years ago, I was living in Buffalo, New York, and managing a rental property. It seemed like every other month brought a new headache: air conditioning breaking down during summer heatwaves, pipes freezing and bursting in the seemingly never-ending winter, and unexpected repairs piling up. While the property had been a solid investment over the years, the day-to-day reality was anything but simple. After a few years, I found myself saying what we often hear from clients, “I don’t want to deal with this anymore.”
Many of our clients at Bragg Financial have built meaningful wealth through investment real estate, including duplexes, small apartment buildings, retail strip centers, and vacation rentals. These properties have served them well over time, generating cash flow and building equity. But at a certain point, the calculus starts to change. The midnight maintenance calls, tenant turnover, and insurance headaches can begin to outweigh the income the property provides.
In some cases, that shift comes as clients approach retirement. In others, it’s a desire to scale back or spend less time managing real estate. We also hear from many clients that their children have little interest in inheriting and managing these properties, which becomes an important consideration in their broader planning. So, what should they do? One option is to sell the property and simplify their balance sheet.
The problem, of course, is the tax bill. And that’s where a thoughtful combination of the 1031 exchange and the Delaware Statutory Trust comes in.
The Capital Gains Problem
If you’ve held investment real estate for decades, you’ve likely accumulated substantial appreciation. Investment real estate is not eligible for the same tax exclusions provided to primary residences. A property purchased for $250,000 in 1995 might be worth $1.2 million today. Selling it outright would trigger federal capital gains tax on the appreciation, plus depreciation recapture taxed at up to 25%, plus any applicable state income tax and the 3.8% net investment income tax. For a North Carolina resident, the combined tax hit can easily approach 30% or more of the gain. On a property with almost a million dollars in appreciation and significant accumulated depreciation, that could mean writing a check for $300,000 or more.
Under Section 1031 of the Internal Revenue Code, however, an investor can defer that entire tax liability by exchanging the proceeds into “like-kind” replacement property, essentially swapping one investment property for another without triggering a taxable event.
The challenge with a typical 1031 exchange is that if you’re selling because you’re tired of being a landlord, the last thing you want is another property that requires the same level of involvement.
Enter the Delaware Statutory Trust
A Delaware Statutory Trust (DST) is a legal entity formed under Delaware law that holds title to real property. Multiple investors can purchase “beneficial interests” in the trust, each owning a fractional share of the underlying real estate. Current IRS guidelines state that a beneficial interest in a properly structured DST qualifies as direct ownership of real property for federal tax purposes. That means an interest in a DST is eligible replacement property in a 1031 exchange.
In practical terms, a DST allows a retiree to sell a hands-on rental property, defer the capital gains through a 1031 exchange, and acquire a passive fractional interest in institutional-quality real estate. This could be a 300-unit apartment complex, a medical office building, or a retail shopping center. The investor receives monthly or quarterly income distributions and never has to receive a midnight call from a tenant telling them the pipes burst, the A/C is broken, or the roof is leaking.
For many investors, a DST is not necessarily the final destination. Instead, it can serve as a transition point from active real estate ownership to a more flexible and liquid structure through what’s known as an UPREIT—an umbrella partnership real estate investment trust. In certain cases, a DST investment can ultimately be converted into REIT ownership (either a privately or publicly traded security that owns and manages real estate), providing increased liquidity and simplifying long-term estate and tax planning. We’ll touch on this in more detail later, but it’s helpful to view the DST not just as a way to go passive, but as part of a broader long-term strategy.
The Appeal of DSTs
DSTs address several challenges simultaneously.
No Management Burden. Many DST properties are structured as triple-net leases, meaning the tenant is responsible for property taxes, insurance, and maintenance. The DST sponsor handles all asset management. You are simply a passive investor in the trust.
Diversification. If you’ve spent your career owning a single property or a small cluster of properties in one market, a DST exchange lets you spread your investment across multiple property types and geographic regions. You might exchange a single duplex into fractional interests across an apartment complex in Dallas, a medical office in Denver, and an industrial distribution center in Atlanta. As our Director of Portfolio Management Ben Rose has written about in the context of equity portfolios, concentration can build wealth, but diversification is the key to preserving it. The same principle applies to real estate, where geographic risk is especially prevalent. In many cases, DSTs offer exposure to institutional-grade properties that would not otherwise be accessible to individual investors (e.g. Class A commercial properties in major urban areas).
Continued Tax Deferral. The 1031 exchange into a DST defers your capital gains and depreciation recapture just as a traditional property-to-property exchange would. You maintain your tax-deferred status and, depending on the DST’s leverage and cost basis, may even receive new depreciation benefits that shelter a portion of your cash flow.
Preserved Step Up in Basis. Under current law, when you pass away, your heirs receive a stepped-up cost basis on inherited assets. That means the capital gains you deferred across one or multiple 1031 exchanges over your lifetime may be eliminated entirely at death. An investor who exchanges from property to property to DST over the course of decades could pass along those real estate interests to the next generation with no capital gains tax owed on the appreciation. As we’ve written about in other contexts, see Simple Solutions to Reduce Your Estate Tax, the combination of tax deferral during life and a stepped-up basis at death is one of the most powerful wealth transfer strategies available.
Predictable income. Many DSTs are structured to provide regular monthly or quarterly distributions to investors, derived from the rental income of the underlying properties. The professionalized cash flow of a DST is stable and easy to plan around, which can be ideal for a retiree.
Limited Liability. DST laws have protections for investors that prohibit investors from incurring personal liability due to the assets owned by the trust. This is in stark contrast to direct ownership of investment real estate, which often carries substantial personal liability and requires significant liability coverage.
Risks and Limitations
DSTs are not without significant trade-offs, so it is important that we also discuss their risks and limitations.
A DST interest is not a publicly traded security. There is no established secondary market. This means that when you invest, you should expect to hold that interest for the life of the trust, which typically runs for two to three years. At the end of the hold period, the sponsor sells the underlying property, distributes proceeds to investors, and the trust dissolves. At that point, you can do another 1031 exchange, take the proceeds (and pay the tax), or pursue another strategy. But during the hold period, your capital is effectively locked up.
Like investing in private funds, the quality of your DST investment depends heavily on the quality of the sponsor. You are relying on the sponsor’s ability to identify, acquire, and manage those properties successfully. Sponsors vary widely in experience, track record, and fee structures. Upfront fees, including acquisition fees, financing coordination fees, and offering costs, can be significant and must be understood before investing. There are many DST managers, some better than others, so performing due diligence before investing is critical.
The Mechanics of a DST
The process follows the same timeline as any 1031 exchange, with one important structural advantage.
When you sell your investment property, the sale proceeds must go directly to a Qualified Intermediary. The Qualified Intermediary is a neutral third party who holds the funds throughout the exchange. From the date of that sale closing, two clocks start running simultaneously. You have 45 calendar days to identify your replacement property in writing and you have 180 calendar days to close on that replacement property. These deadlines are strict, cannot be extended under normal circumstances, and include weekends and holidays. Missing either deadline causes the entire exchange to fail, and the full capital gain becomes taxable.
Unlike a traditional 1031 exchange, where you must find, negotiate, inspect, and close on a specific property within those tight windows, some DST sponsors maintain “shelf offerings.” These are pre-packaged investment opportunities in properties the sponsor has already acquired and are available for 1031 exchange investors. These offerings are ready to close quickly, often within days. This makes DSTs particularly valuable as a backup identification option. Even if you’re pursuing a direct property exchange, identifying one or two DST offerings alongside your target property ensures you have a viable fallback if the primary deal falls through before day 180.
The DST Exit Strategy
The holding period with a DST should be relatively hands-off. It is important, however, to consider the DST’s exit strategy prior to the end of the holding period, and ideally before entering a DST.
Some DSTs are designed as a cash exit. This means that the trust company will sell the underlying asset and distribute the cash to the owners of the trust. Once the holding period ends and the cash is distributed, you’ll be left with the same choice all over again. Should I take the cash and pay the taxes, or should I roll this into another 1031 exchange? That constant exchange process can start to feel burdensome over time.
This is where the 721 exchange offers an increasingly popular alternative. Section 721 provides that no gain or loss is recognized when property is contributed to a partnership in exchange for an interest in that partnership. In the DST context, this works through a structure known as an UPREIT, short for Umbrella Partnership Real Estate Investment Trust. When your DST reaches the end of its hold period, rather than selling the property and distributing cash, the sponsor contributes the DST’s real estate into the operating partnership of an affiliated REIT. In exchange for your fraction of the real estate held by the DST, you receive operating partnership units in the REIT. This is ideal because REIT shares can easily be redeemed for cash, making them far more manageable from a liquidity, tax, and estate planning perspective. You can sell them when you need cash and spread your capital gain across multiple transactions and tax years.
There is an important trade-off to understand. Once your DST interest converts into OP units or REIT shares through a 721 exchange, you can no longer use a 1031 exchange to defer gains on a future sale. REIT shares are securities, not real property, and are therefore ineligible for 1031 treatment. The 721 exchange is, in effect, the final stop on the tax-deferral train. From there, you can either hold the investment through your lifetime, at which point your heirs will receive a step-up in basis. Or you can sell part or all of your shares over time in a tax-efficient manner.
If you’re navigating a similar decision with investment real estate, we’d welcome the opportunity to talk through your options. Please don’t hesitate to reach out to us at Bragg Financial.
This information is believed to be accurate at the time of publication but should not be used as specific investment or tax advice as opinions and legislation are subject to change. You should always consult your tax professional or other advisors before acting on the ideas presented here.
Bragg Financial Acts Fast to Help Bring Play-based Learning to CMS
June 15, 2026A few years ago, I was living in Buffalo, New York, and managing a rental property. It seemed like every other month brought a new headache: air conditioning breaking down during summer heatwaves, pipes freezing and bursting in the seemingly never-ending winter, and unexpected repairs piling up. While the property had been a solid investment over the years, the day-to-day reality was anything but simple. After a few years, I found myself saying what we often hear from clients, “I don’t want to deal with this anymore.”
Many of our clients at Bragg Financial have built meaningful wealth through investment real estate, including duplexes, small apartment buildings, retail strip centers, and vacation rentals. These properties have served them well over time, generating cash flow and building equity. But at a certain point, the calculus starts to change. The midnight maintenance calls, tenant turnover, and insurance headaches can begin to outweigh the income the property provides.
In some cases, that shift comes as clients approach retirement. In others, it’s a desire to scale back or spend less time managing real estate. We also hear from many clients that their children have little interest in inheriting and managing these properties, which becomes an important consideration in their broader planning. So, what should they do? One option is to sell the property and simplify their balance sheet.
The problem, of course, is the tax bill. And that’s where a thoughtful combination of the 1031 exchange and the Delaware Statutory Trust comes in.
The Capital Gains Problem
If you’ve held investment real estate for decades, you’ve likely accumulated substantial appreciation. Investment real estate is not eligible for the same tax exclusions provided to primary residences. A property purchased for $250,000 in 1995 might be worth $1.2 million today. Selling it outright would trigger federal capital gains tax on the appreciation, plus depreciation recapture taxed at up to 25%, plus any applicable state income tax and the 3.8% net investment income tax. For a North Carolina resident, the combined tax hit can easily approach 30% or more of the gain. On a property with almost a million dollars in appreciation and significant accumulated depreciation, that could mean writing a check for $300,000 or more.
Under Section 1031 of the Internal Revenue Code, however, an investor can defer that entire tax liability by exchanging the proceeds into “like-kind” replacement property, essentially swapping one investment property for another without triggering a taxable event.
The challenge with a typical 1031 exchange is that if you’re selling because you’re tired of being a landlord, the last thing you want is another property that requires the same level of involvement.
Enter the Delaware Statutory Trust
A Delaware Statutory Trust (DST) is a legal entity formed under Delaware law that holds title to real property. Multiple investors can purchase “beneficial interests” in the trust, each owning a fractional share of the underlying real estate. Current IRS guidelines state that a beneficial interest in a properly structured DST qualifies as direct ownership of real property for federal tax purposes. That means an interest in a DST is eligible replacement property in a 1031 exchange.
In practical terms, a DST allows a retiree to sell a hands-on rental property, defer the capital gains through a 1031 exchange, and acquire a passive fractional interest in institutional-quality real estate. This could be a 300-unit apartment complex, a medical office building, or a retail shopping center. The investor receives monthly or quarterly income distributions and never has to receive a midnight call from a tenant telling them the pipes burst, the A/C is broken, or the roof is leaking.
For many investors, a DST is not necessarily the final destination. Instead, it can serve as a transition point from active real estate ownership to a more flexible and liquid structure through what’s known as an UPREIT—an umbrella partnership real estate investment trust. In certain cases, a DST investment can ultimately be converted into REIT ownership (either a privately or publicly traded security that owns and manages real estate), providing increased liquidity and simplifying long-term estate and tax planning. We’ll touch on this in more detail later, but it’s helpful to view the DST not just as a way to go passive, but as part of a broader long-term strategy.
The Appeal of DSTs
DSTs address several challenges simultaneously.
No Management Burden. Many DST properties are structured as triple-net leases, meaning the tenant is responsible for property taxes, insurance, and maintenance. The DST sponsor handles all asset management. You are simply a passive investor in the trust.
Diversification. If you’ve spent your career owning a single property or a small cluster of properties in one market, a DST exchange lets you spread your investment across multiple property types and geographic regions. You might exchange a single duplex into fractional interests across an apartment complex in Dallas, a medical office in Denver, and an industrial distribution center in Atlanta. As our Director of Portfolio Management Ben Rose has written about in the context of equity portfolios, concentration can build wealth, but diversification is the key to preserving it. The same principle applies to real estate, where geographic risk is especially prevalent. In many cases, DSTs offer exposure to institutional-grade properties that would not otherwise be accessible to individual investors (e.g. Class A commercial properties in major urban areas).
Continued Tax Deferral. The 1031 exchange into a DST defers your capital gains and depreciation recapture just as a traditional property-to-property exchange would. You maintain your tax-deferred status and, depending on the DST’s leverage and cost basis, may even receive new depreciation benefits that shelter a portion of your cash flow.
Preserved Step Up in Basis. Under current law, when you pass away, your heirs receive a stepped-up cost basis on inherited assets. That means the capital gains you deferred across one or multiple 1031 exchanges over your lifetime may be eliminated entirely at death. An investor who exchanges from property to property to DST over the course of decades could pass along those real estate interests to the next generation with no capital gains tax owed on the appreciation. As we’ve written about in other contexts, see Simple Solutions to Reduce Your Estate Tax, the combination of tax deferral during life and a stepped-up basis at death is one of the most powerful wealth transfer strategies available.
Predictable income. Many DSTs are structured to provide regular monthly or quarterly distributions to investors, derived from the rental income of the underlying properties. The professionalized cash flow of a DST is stable and easy to plan around, which can be ideal for a retiree.
Limited Liability. DST laws have protections for investors that prohibit investors from incurring personal liability due to the assets owned by the trust. This is in stark contrast to direct ownership of investment real estate, which often carries substantial personal liability and requires significant liability coverage.
Risks and Limitations
DSTs are not without significant trade-offs, so it is important that we also discuss their risks and limitations.
A DST interest is not a publicly traded security. There is no established secondary market. This means that when you invest, you should expect to hold that interest for the life of the trust, which typically runs for two to three years. At the end of the hold period, the sponsor sells the underlying property, distributes proceeds to investors, and the trust dissolves. At that point, you can do another 1031 exchange, take the proceeds (and pay the tax), or pursue another strategy. But during the hold period, your capital is effectively locked up.
Like investing in private funds, the quality of your DST investment depends heavily on the quality of the sponsor. You are relying on the sponsor’s ability to identify, acquire, and manage those properties successfully. Sponsors vary widely in experience, track record, and fee structures. Upfront fees, including acquisition fees, financing coordination fees, and offering costs, can be significant and must be understood before investing. There are many DST managers, some better than others, so performing due diligence before investing is critical.
The Mechanics of a DST
The process follows the same timeline as any 1031 exchange, with one important structural advantage.
When you sell your investment property, the sale proceeds must go directly to a Qualified Intermediary. The Qualified Intermediary is a neutral third party who holds the funds throughout the exchange. From the date of that sale closing, two clocks start running simultaneously. You have 45 calendar days to identify your replacement property in writing and you have 180 calendar days to close on that replacement property. These deadlines are strict, cannot be extended under normal circumstances, and include weekends and holidays. Missing either deadline causes the entire exchange to fail, and the full capital gain becomes taxable.
Unlike a traditional 1031 exchange, where you must find, negotiate, inspect, and close on a specific property within those tight windows, some DST sponsors maintain “shelf offerings.” These are pre-packaged investment opportunities in properties the sponsor has already acquired and are available for 1031 exchange investors. These offerings are ready to close quickly, often within days. This makes DSTs particularly valuable as a backup identification option. Even if you’re pursuing a direct property exchange, identifying one or two DST offerings alongside your target property ensures you have a viable fallback if the primary deal falls through before day 180.
The DST Exit Strategy
The holding period with a DST should be relatively hands-off. It is important, however, to consider the DST’s exit strategy prior to the end of the holding period, and ideally before entering a DST.
Some DSTs are designed as a cash exit. This means that the trust company will sell the underlying asset and distribute the cash to the owners of the trust. Once the holding period ends and the cash is distributed, you’ll be left with the same choice all over again. Should I take the cash and pay the taxes, or should I roll this into another 1031 exchange? That constant exchange process can start to feel burdensome over time.
This is where the 721 exchange offers an increasingly popular alternative. Section 721 provides that no gain or loss is recognized when property is contributed to a partnership in exchange for an interest in that partnership. In the DST context, this works through a structure known as an UPREIT, short for Umbrella Partnership Real Estate Investment Trust. When your DST reaches the end of its hold period, rather than selling the property and distributing cash, the sponsor contributes the DST’s real estate into the operating partnership of an affiliated REIT. In exchange for your fraction of the real estate held by the DST, you receive operating partnership units in the REIT. This is ideal because REIT shares can easily be redeemed for cash, making them far more manageable from a liquidity, tax, and estate planning perspective. You can sell them when you need cash and spread your capital gain across multiple transactions and tax years.
There is an important trade-off to understand. Once your DST interest converts into OP units or REIT shares through a 721 exchange, you can no longer use a 1031 exchange to defer gains on a future sale. REIT shares are securities, not real property, and are therefore ineligible for 1031 treatment. The 721 exchange is, in effect, the final stop on the tax-deferral train. From there, you can either hold the investment through your lifetime, at which point your heirs will receive a step-up in basis. Or you can sell part or all of your shares over time in a tax-efficient manner.
If you’re navigating a similar decision with investment real estate, we’d welcome the opportunity to talk through your options. Please don’t hesitate to reach out to us at Bragg Financial.
This information is believed to be accurate at the time of publication but should not be used as specific investment or tax advice as opinions and legislation are subject to change. You should always consult your tax professional or other advisors before acting on the ideas presented here.
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